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3 Things: Freight, Deflation, No Hike

Freight Volumes Suggest Weak Growth

We often look at broad measures of the economy to determine its current state. However, we can often receive clues about where the economy may be headed by looking at data that feeds into the broader measures. Exports, imports, wage growth, commodity prices, etc. all have very important ties to the health of the consumer which is critical to an economy that is nearly 70% driven by their consumption.

While I have discussed the importance those issue in the past, there are other indicators that can also provide valuable clues. One such example is the Cass Freight Index. From the Cass website:

"Data within the Index includes all domestic freight modes and is derived from $26 billion in freight transactions processed by Cass annually on behalf of its client base of hundreds of large shippers. These companies represent a broad sampling of industries including consumer packaged goods, food, automotive, chemical, OEM, retail and heavy equipment. Annual freight volume per organization ranges from $1 million to over $1 billion. The diversity of shippers and aggregate volume provide a statistically valid representation of North American shipping activity."

The chart below is the annual change in both the shipments and expenditures on freight shipments since 1999.

While there is much hope that the current economic recovery will somehow magically obtain 3% annualized growth in the quarters ahead, freight shipments are suggesting weakness.

This is not surprising given the weakness in commodities, exports and wage growth in recent months which all confirm the same. While this does not mean that the economy is about to slip into an immediate recession, it does suggest that the economy is far weaker than headlines currently suggest.

Deflationary Pressures On The Rise

Speaking of exports and imports, imports are currently suggesting that deflationary pressures are once again on the march globally. Deflationary pressures abroad ultimately force down import prices into the US economy which aggravates the deflationary cycle. With the strong dollar dragging on exports, a decline in import prices further deteriorates corporate profitability.

"We expect the acceleration of EM devaluations to send waves of deflation to the west to overwhelm already struggling corporate profitability and take us back into outright recession. As investors realize yet another recession beckons, without any normalization of either interest rates or fiscal imbalances in this cycle, expect a financial market rout every bit as large as 2008."

There are a couple of important points that Mr. Edwards is making. The first is that in an already weak economic environment, further deflationary pressures will continue to detract from corporate profitability and further slow already slow economic growth. Secondly, and more critically, with interest rate policy still near the zero bound there are few policy tools available to combat an economic recession.

The chart below shows the annual change in imports and exports. Imports are driven by domestic demand. As consumers demand more goods or services, imports increase to fulfill that demand. Exports are an indication of global demand. Therefore, if the economy is expected to grow more strongly in the quarters ahead, should not imports and exports be on the rise?

"To Hike, Or Not To Hike?"

"The Federal Reserve has a very difficult challenge ahead of them with very few options. While increasing interest rates may not "initially" impact asset prices or the economy, it is a far different story to suggest that they won't. In fact, there have been absolutely ZERO times in history that the Federal Reserve has began an interest-rate hiking campaign that has not eventually led to a negative outcome.

While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility they will anyway.

The Fed understands that economic cycles do not last forever, and we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed's perspective it might be the 'lesser of two evils. Being caught at the "zero bound" at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline."

The Federal Reserve as of late have issued repeated statements that rates are set to rise at the September meeting. However, with China's financial and economic troubles on the rise, the negative impact of the surging US dollar, rising deflationary forces globally and falling asset prices; there is a rising probability they will push off the rate hike until the end of the year.

The problem for the Fed is they are now likely "behind the curve" and will be caught with interest rates too low when the next recessionary cycle sets in.

Importantly, as stated above, I am not suggesting that the economy is about to slip into an immediate recession. However, I am stating that all economic cycles do eventually end. When the current economic growth cycle begins to contract, if the Fed is still stuck at the zero bound it leaves them few policy options available to offset the risk to the financial markets. This is why I tend to agree with Mr. Edwards point that such a combination of events could lead to a mean-reverting event on par with the past two recessionary periods.

The combination of these data points continues to support my long-held thesis that the "Bond Bull Market" is still far from over. Despite the majority of analysts continuing to be wrong about rates rising, the reality is the persistent wave of global deflationary pressures will continue to support bond prices in the future.

Given that interest rates are ultimately tied to economic growth and inflation, it is highly likely we will see interest rates on the 10-year Treasury below 1% during the next recessionary cycle.

The Fed is rapidly coming to realize they are caught in a "liquidity trap." The problem is they have been betting on a "one trick pony" that by increasing the "wealth effect" it will ultimately lead to a return of consumer confidence and a fostering of economic growth?